Chesapeake Energy: BofA Still Says Buy, Sterne Agee Is Cautious

Shares of Chesapeake Energy (CHK) took a beating yesterday after news broke of the CEO’s loan practices, and the stock was about flat this afternoon.

Analysts are reacting to the news today, with Bank of America Merrill Lynch analyst Doug Leggate reiterating his Buy rating and $38 price target, as he sees the news as �immaterial to the investment case,� and the stocks� steep decline as �unfounded.�

�By our analysis CHK has no balance sheet stress � but this appears still to lie at the root of CHK�s share price volatility and ignores the fact that the 2012 capital plan is almost entirely discretionary: no one is forcing management to spend $12bn of capital. But it is perhaps the disconnect between embedded asset value that will be made all the more tangible through disposals in 2012 and the current share price that is the most salient aspect of recent performance: with ~$3-$4bn of operating cash flow expected in 2012 even in the worst of gas price scenarios and some $10bn-$12bn of noncore asset monetization well under way, on our estimates, the scale of cash likely to be released in 2012 alone exceeds the entire market capitalization of the stock at current levels. We contend this mismatch suggests something is being mispriced in the stock.

Recognizing again the obvious controversies surrounding the stock, we believe at current levels the value proposition associated with execution of its three stage plan to harvest assets, shift production to liquids and reduce debt is compelling. If the disconnect is simply an aversion to Aubrey�s alleged personal financial appropriations, at some point, we wonder when management�s patience wears thin enough to embark on another asset buying spree � perhaps to buy back its own stock. Buy.�

However, Sterne, Agee & Leach analyst Tim Rezvan was more cautious on the name, reiterating his Neutral rating on Chesapeake as he does not see any imminent liquidity issues facing the stock. But he thinks investors should understand the �impact of prolonged weak gas prices on their cash flow generation ability.� His analysis is below:

“We assume a capital program of $11.675 billion in 2012 and $11.375 billion in 2013, and asset sales of $10 billion in 2012 and $4.5 billion in 2013. Our current price deck for natural gas is $2.80/mcf in 2012 and $3.60/ mcf in 2013. We held spending and asset sales constant when stressing natural gas prices. We would note that we did not plan for debt paydown in 2012, although the company has pledged to reduce debt to $9.5 billion from the current level of $10.6 billion.

Results Suggest no Issue in 2012, Although Smaller 2012 Cushion Minimizes Capital to Offset 2013 Gas Price Weakness. By stressing gas down to $1/mcf from 2Q12 through 4Q12, we still see positive FCF of over $1.6 billion. However, we believe the company will need to build up a larger cash buffer to fund 2013 plans, which will not benefit from such substantial asset sales.

2013 Gas Prices Could Force Company Hand on Capital Spending. Assuming a flat $2/mcf price through 2013, we believe the company would have to decrease spending or accelerate 2013 asset sales above its stated target of $4.5 billion. We estimate aggregate FCF neutrally from 2012-13 at approximately $1.75/mcf. At that price, total FCF of ~$1.1 billion would be netted out by the $1.1 billion debt paydown by year-end 2012. We view this scenario as unlikely but plausible, with gas trading at $1.94/mcf today.”